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A financial adviser has suggested that instead of saving my cash in a United Kingdom building society, I should invest in an offshore open-ended investment vehicle (OEIC), which in turn holds cash or other money market funds.
These products are apparently run by household name companies from their subsidiaries in places like the Channel Islands or the Isle of Man.
A financial adviser has suggested that instead of saving my cash in a United Kingdom building society, I should invest in an offshore open-ended investment vehicle (OEIC), which in turn holds cash or other money market funds.
These products are apparently run by household name companies from their subsidiaries in places like the Channel Islands or the Isle of Man.
The adviser says that although I would just be holding cash, the return on this investment will be treated as a dividend, taxable at 10% rather than at the 20% charged on interest. This seems too good to be true; is it?
Readers' views are welcomed.
Query T16,812 — Sceptic.
Reply by Jerseyman:
If you ignore for the moment any income tax anti-avoidance legislation, the dividend from an offshore open-ended investment company (OEIC) would be taxable in the hands of a basic rate taxpayer at a rate of 10%, regardless of the source of the underlying income. Since it is a foreign dividend, there is of course no notional tax credit attached to the dividend. To the extent that the foreign dividend is received by a higher rate taxpayer, it falls to be taxed at a rate of 32.5%. It is important to note that any tax withheld from interest arising in the underlying investment is not available to set against the tax due on the foreign dividend.
We do need to consider whether the anti-avoidance provisions set out in TA 1988, s 739 apply to treat the underlying income of the OEIC as the investor's, effectively looking through the OEIC. If s 739 is deemed to apply in this instance, the investor in the OEIC will be taxed on the interest as it arises, chargeable at the savings tax rate of 20%, assuming that the investor is a basic rate taxpayer.
In this instance, the conditions for the application of s 739 appear to be satisfied inasmuch as there has been a 'transfer of assets' to the OEIC by the UK resident investor, which has resulted in income being paid to the offshore entity. The investor, as 'transferor' of those assets, has the 'power to enjoy' the income of the offshore OEIC.
The taxation of interests in offshore funds is dealt with in a separate anti-avoidance taxing code, namely TA 1988, ss 756 to 764, which is intended primarily to address the roll up of income offshore. In CIR v Willoughby [1997] STC 995, it was held that since the offshore bonds in question were already subject to the specific life policy anti-avoidance tax provisions of TA 1988, ss 539 to 554, their use could not also constitute tax avoidance for the purposes of s 739. However, this line of defence is not robust.
In practice, where an offshore fund adopts a full distribution policy HMRC will generally not seek to tax the investor on the underlying investment income under s 739. However, it is unlikely that HMRC would feel inclined to follow this approach where a clear tax avoidance motive has driven the structure. In circumstances where an offshore OEIC holding only cash or other money market funds for a UK resident investor results in a beneficial tax rate differential with no commercial benefit or exposure, one cannot imagine that HMRC would accept a 'motive defence' under the strengthened TA 1988, s 741A. I do fear that 'Sceptic' is right to be sceptical.
Reply by Part Timer:
Sceptic is considering holding his cash through an offshore OIEC so that he receives a dividend taxable at either 10% or 32.5% (TA 1988, s 1B(2). Clearly, this would be better than being taxed at either 20% or 40%, the rates applying to interest received from a United Kingdom or offshore bank or other company.
Sceptic appears to envisage that the offshore OEIC will make regular distributions, the same as any ordinary bank account. In that case, there should be no question of the income being taxed under the anti-avoidance legislation of TA 1988, s 739 relating to the 'transfer of assets abroad'. Sceptic should take care to ensure that he does not invest in an offshore roll up fund caught by the anti-avoidance provisions of TA 1988, s 756A to 764 and Schedules 27 and 28. This legislation was introduced to counter what was seen as an unfair competitive advantage for offshore funds, which could accumulate their income within the fund without paying it out annually. Gains arising from these funds are taxable as income and charged to tax at either the basic or higher rate. To avoid the rules, an offshore fund must meet certain conditions, one of which is that it must distribute at least 85% of its income annually.
A distribution from a UK OEIC that is invested in fixed interest or cash funds is generally treated as interest in the hands of the shareholder (see ITTOIA 2005, s 373). Provided that the OEIC meets certain qualifying tests relating to the market value of its interest bearing assets, it can make distributions of interest, which can be tax advantageous for the OEIC itself (TA 1988, s 468 et seq.). These regulations do not appear to apply, however, to offshore OEICs, whose distributions are generally treated as dividends (see TA 1988, s 468A(2)).
But before Sceptic rushes to sign up he should check the bottom line to identify the net interest rate after the management expenses and other charges that are often associated with offshore funds. I have checked with some IFA contacts and they are not aware of such a product being widely available.
